Why it’s time to get bullish on mining with BHP Billiton Limited and Rio Tinto Limited

Buying cyclical stocks when their industry is down sets you up for future returns.

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Value investors love a good industrial slump. It weeds out the weaker companies, exposing financial problems which a strong market may cover up. It can also brings share prices down more in line with true intrinsic value.

Could the mining industry go down further from here? Possibly. Will the major miners close up shop, and wind down the companies? No. They adjust while the commodities markets adjust to new realities.

BHP Billiton Limited (ASX: BHP), the biggest miner on the ASX, makes up about 47% of the S&P ASX 100 Resources Index (ASX: ^XTR). Its share price has been up more than 20% since late June. 30% of its revenue comes from iron ore, so even before iron ore prices rallied in 2013, it was still carrying out its plan to increase production.

Now it is benefitting from that move and while commodity prices are up, segment earnings will be going up. It announced in its half-year operational review that it set a production record of 108 million tonnes of iron ore, so if unit price is up and volume is up, then revenue is up.

Likewise, QLD coal was up to a half-year record production of an annualised 68 million tonnes. Thermal coal prices have been sluggish, but they have slowly nudged their way up since August, going from about $82.45 to $90.36 in December. Coking coal prices have come down from $170/tonne last year to about $127/tonne.

Its third-largest revenue source is copper at 18.4%. Its half-year production volumes were up 6% compared to the prior corresponding period (pcp).

Rio Tinto Limited (ASX: RIO) also put out an operational review of the December quarter. It saw a 6% increase to 70.4 million tonnes of iron ore production compared to the pcp. Copper ore, its number two resource for revenue, was up to 172.8 thousand tonnes which was a 5% increase over the pcp.

Hard coking coal production was up 25% compared to the pcp, whereas thermal and semi-soft coal was down 9%.

The company’s Oyu Tolgoi copper mine in Mongolia was finally raised to full production capacity, following delays caused by negotiations with the Mongolian government.

Foolish takeaway

The big miners are ramping up production to ensure that earnings are up, even if profit margins may get squeezed.

In general, cost-cutting initiatives may slow down earnings in the short-term and write-downs and asset revaluations lower equity, but once they are done and dusted, the financial ship that is the balance sheet will be much less burdened. When economic tailwinds start blowing again, it will move faster with better sales. If investors buy into a weak industry, then value may be exposed. Once the industry starts picking up, the opportunity will be lost for another business cycle.

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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned. 

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